1 LAPPEENRANTA UNIVERSITY OF TECHNOLOGY
School of Business and Management
Master’s Programme in Business Administration Supply Management
Master Thesis
INTERNATIONAL PROCUREMENT OFFICE IN VIETNAM
1st supervisor: Professor Veli Matti Virolainen
2nd supervisor: Associate Professor Katrina Lintukangas
Son Tung, Vo 2018
2 ABSTRACT
Author: Vo, Son Tung
Title: International Procurement Office in Vietnam Faculty: LUT School of Business and Management Major: Supply Management
Year: 2018
Master’s Thesis: Lappeenranta University of Technology 106 pages, 9 figures, 7 tables, 1 appendix Examiners: Professor Veli-Matti Virolainen
Associate professor Katrina Lintukangas
Keywords: International procurement office, supply chain management, global supply chain, strategic sourcing, offshoring.
The objective of the thesis is to redefine the concept of International Procurement Office (IPO).
Specifically, location, activities which can be assigned, advantages and disadvantages of IPO are studied. Another aim of the thesis is to explain the reasons behind IPO establishment of international corporations, from that provide a possible strategy that can be applied in the modern economy as well as some notices if companies want to implement IPO solution. The study is a qualitative research, which uses interviews as the main data collection method. During interviews, participants go through a set of questions which were designed following factors mentioned in existing literatures. these elements are examined to build an overview of the current situation of the application. Moreover, during data collection process, experts were encouraged to give their personal views and opinions on the questions and suggestions for future works. Advices for companies are also expected to be received in these discussions. So, a full manual of IPO establishment is the main target result of the research.
The concept of IPO is expanding is main result of the thesis. Firstly, while the initial idea of external procurement office is to manage purchasing activities in developing countries like China, IPOs are nowadays set up in both developed and developing countries. Secondly,
3 sourcing and purchasing activities are still core activities of these offices but they have currently been receiving more roles from headquarters. Main advantages and disadvantages of the strategy are also reviewed. The balance of benefits and how to define the power of these offices are two of the most important points companies need to focus in this strategy.
4 PREFACE
Three years in Lappeenranta has been a dream come true for me. Now it is coming to the last days, much faster than I expected. When a long and wonderful story comes to an end, I am glad to say that I always have great people stay by my side. Without them, I would not be here today.
Firstly, I would like to thank my supervisors, Professor Veli Matti Virolainen and Associate Professor Katrina Lintukangas, for all the comments, guidelines and support. I also want to thank all the experts and companies who agreed to offer me their time, knowledge and experience to complete this thesis. Without all information and advices from them, the work would not be done.
Moving to another country to study is never easy, and my time here would have been much harder without my friends: Trang, Phuong, Nhat, Vu and Duy. Thank you very much for all for your support when I got depressed and lost.
Finally, I would like to give a huge hug to my family. They are always there when I need, give me advices and encourage me to reach my goal. Thanks to my brother, Nam. You may not speak much, but all the supports from you give me lot of motivation to take further steps and follow my dream.
Espoo, 30.04.2018 Vo Son Tung
5 TABLE OF CONTENTS
1. INTRODUCTION ... 9
1.1. Background ... 9
1.2. Literature review ... 10
1.3. Research questions ... 11
1.4. Research framework and key concepts ... 12
1.4.1. Supply chain management ... 13
1.4.2. Global supply chain ... 14
1.4.3. Strategic sourcing ... 14
1.4.4. Offshoring ... 14
1.5. Thesis structure ... 15
2. IPO THEORY ... 17
2.1. Global sourcing ... 17
2.1.1. Global sourcing becomes survival strategy in globalization age ... 17
2.1.2. Global sourcing concept ... 18
2.1.3. Global sourcing: Benefits and challenges ... 19
2.1.4. Global sourcing choices: The dynamics of Offshoring and Outsourcing ... 23
2.2. Offshoring ... 25
2.2.1. On the concepts of offshoring ... 25
2.2.2. Theoretical aspects of offshoring decision: ... 27
2.2.3. Offshoring motives ... 29
2.2.4. Risks ... 32
2.3. IPO... 35
2.3.1. IPO as a part of global sourcing stages ... 35
2.3.2. IPO definition ... 37
2.3.3. Roles and activities performed by IPOs ... 39
2.3.4. Setting up an IPO ... 43
2.3.5. Strengths ... 46
2.3.6. Weakness ... 48
3. RESEARCH METHODOLOGY AND DATA COLLECTION PLAN ... 50
3.1. Research methodology ... 50
3.2. Description of interviewees ... 51
6
3.3. Data collection plan ... 53
4. EMPIRICAL ... 55
4.1. Interviewed case companies ... 56
4.2. IPO’s activities ... 58
4.2.1. Supplier management ... 58
4.2.2. Supply chain operations ... 62
4.2.3. Other activities ... 64
4.3. Establishing an IPO ... 70
4.4. Advantages ... 73
4.4.1. Cost advantages ... 73
4.4.2. Performance advantages ... 75
4.4.3. Relationships advantages ... 77
4.4.4. Information management ... 78
4.4.5. Other benefits ... 79
4.5. Weaknesses ... 83
4.6. Overall ... 85
5. CONCLUSIONS ... 88
5.1. Main results ... 88
5.2. Limitations and future researches ... 91
REFERENCES ... 93
APPENDIX ... 101
7 LIST OF FIGURES
Figure 1: Theoretical framework ... 13
Figure 2: Thesis structure ... 16
Figure 3: Sources of Risks in Supply chain ... 22
Figure 4: Global sourcing choices ... 24
Figure 5: Offshoring motives ... 32
Figure 6: Offshoring risks ... 33
Figure 7: Levels of IPOs ... 43
Figure 8: Steps to establish an IPO ... 44
Figure 9: Results of evaluation of important of IPO’s activities ... 67
8 LIST OF TABLES
Table 1:Summary of the interviewees ... 51
Table 2: Interview themes ... 55
Table 3: Case company's basic information ... 57
Table 4: Results of evaluation of important of IPO’s activities ... 68
Table 5: Results of IPO's establishment steps ... 72
Table 6: Results of IPO's advantages evaluation ... 80
Table 7: Results of IPO's disadvantages evaluation ... 85
9 1. INTRODUCTION
1.1. Background
In one best-selling book, The world is flat, Friedman (2005) argued that the world is entering new age, the age of globalization, in which it becomes smaller and flatter, with the high pressure of international competition, the disappearance of physical national borders and the spreading of new communication and information technology. Those elements force companies to find out appropriate strategies to optimize their performance, cost effectiveness and value creation.
International sourcing, in which companies look for materials and services outside their national borders, presents a key success factor in this situation: company costs and performance optimization can be gained from improving purchasing activities by using wider range of sources. This strategy takes a more important role in increasing value created, since purchasing activities contribute more than a half of company’s value creation, with more than 50 percent in service companies and up to 70 percent in manufactures (Zeng, 2000).
Due to the huge potential of international sourcing, companies have a growing interest towards developing and reorganizing their supply chain network to transfer from local to global sources.
Increase in number of sources leads to the complexity in supply chain network, including cultural heterogeneities, difficulties in arranging conversations due to time zone difference, distant interlocutors, rules and behavior differences. Changes in business strategies and processes are needed to tackle these challenges.
There is another trend in modern global business, in which companies transfer their production from developed to developing countries, such as China, India and Vietnam to improve their competitive advantages. This movement leads to a critical question: should the company keep their original business? On one hand, they can choose keeping their existing relationships, however, their information and material flows will be extended. On the other hand, they can create new business relationship with new factories with needs of having business intelligent about environment elements in new markets. They need an emergent strategy.
Those proactive and reactive elements bring the need of reviewing company goals, objectives and strategies to adjust the way to achieve effective goods and service acquisition. These
10 requirements also highlight the need to identify which parts of the world are suitable, deeply understand about factors that impact purchasing process and strategies. Establishing International Procurement Offices (IPOs) is suggested as a possible solution.
This thesis is a review of activities of international companies in Vietnam, which are using IPOs as a purchasing strategy. The background of this thesis comes from the need to develop appropriate strategy for purchasing process when production and service center are moving to
“low-cost” countries. Vietnam is selected as a targeted market. Known as one of the “MITI-V”, group of Asia Pacific countries includes Malaysia, Thailand, Indonesia, India and Vietnam who have potentials to replace China to become lower-cost manufacturing destinations (Deloitte, 2016), the country is where newest purchasing strategies are applied.
1.2. Literature review
In today business, global sourcing becomes a strategic opportunity for firms to keep sustainable success (Kim & Chai, 2017). The growth of global sourcing encourages researchers to study various aspects of it, including IPOs strategy (Sartor et al., 2014). There are two trends of the development of global sourcing, the increasing involvement in global market and the transfer from transactional to strategic (Jia et al., 2014). These trends lead to the implementation of IPOs as a necessary step after finishing initial stages of global sourcing process (Jia et al., 2014).
Together with the increasing importance of IPO strategy in global sourcing, setting up IPOs is realized as a common strategy for international sourcing management (Sartor, 2007).
Despite the increasing importance of IPO strategy, few researches are published on this topic and most of them did not tackle it systematically and in relation with other concepts and applications (Jia et al., 2014). many definitions of IPOs were provided, such as “intermediaries”,
“shared service entities”, “full-service procurement centers” etc. (Jia et al., 2014). As a result, they cannot capture all aspects of IPO strategy and activities (Jia et al., 2014b). One possible definition of IPO concept that: “an off-shore buying house or office which was established by an original equipment manufacturer (OEM) to procure raw materials, components, semi- finished parts and other input in a competitive price for global manufacturing plants” (Goh &
Lau, 1998).
11 However, there are some problems in this definition and it needs to be updated. Firstly, this concept was developed based on a research from Western and Japanese electronics companies located in Singapore in the middle of 1990s (Goh & Lau, 1998), so it needs more examination in other countries. Secondly, the expression of “global plant” is not clear enough, it could cause misunderstanding about place of the plant, whether it could be in host country where the IPO was established (Sartor et al., 2014). And finally, recent literatures emphasize that the concept of IPOs is expanding following the increase of number of activities that are transferred from headquarter to IPOs (Sartor et al., 2014). Finding a working definition of IPOs and examining it in a new country is suggested to update the definition.
1.3. Research questions
Purchasing activities have high a contribution to company’s performance and competitive advantages, so having appropriate purchasing strategies is a key factor for any company to keep their survival and sustainable success. From the combination of the need of organizations to have an efficient way to manage purchasing process. In addition, many top international corporates are using IPOs as the main strategy of global sourcing, the aim of this paper is to give a basic overview about IPOs strategy as a possible solution for strategic making. Moreover, common reasons why companies choose IPO strategy are investigated to explain the decision.
Therefore, the main question of this thesis is:
- Why do companies in Vietnam choose International Procurement Offices as their main purchasing strategy?
In order to answer the research question and company’s decision, a theory background about purchasing strategies and IPOs should be provided. In addition, the research will try to describe how IPO strategy is applied in supply chain network and how it influences the company’s activities in general. Therefore, the sub-questions are:
- What is IPO? What are common purchasing tasks operated in IPOs?
- What are advantages of using IPOs?
- What are disadvantages of using IPOs?
12 The reason why companies use IPOs strategy can be explained by answering the questions above. The thesis provides a basis information about how IPO strategy can operate, possible tasks that can be transferred from headquarter to IPOs and some noticeable points company should look into before starting their project. In addition, some information on Vietnam market is given to encourage international company to find out business opportunities there as a potential sourcing destination.
1.4. Research framework and key concepts
Theoretical framework of the thesis is described in figure 1. As the name of the topic is
“International procurement offices in Vietnam”, main target of the thesis is to review activities of companies, evaluate the benefits, weakness and identify some suggestions during the operations. Major objective of the paper is explaining why companies choose IPOs as their strategy for global sourcing management, through providing reasons why IPOs are applied in Vietnam, current activities, benefits and problems of the sourcing methods from interviewee’s perspectives. From that, the writer will try to provide an understanding of the concept and come up with reasons company may think about when they decide to choose IPOs and their main purchasing channels.
During research process, the paper will start with some theoretical background on new trend in the global economy: globalization and its pressures forcing companies to choose global sourcing to survive. In the next step, main tools to operate sourcing activities are mentioned, which follow two trends: using a third party to operate or moving the activities to cheaper destinations. The literature also explains why companies choose offshoring, and one of its strategy is establishing IPOs as their new way to success.
After having a theoretical view of IPO and how it can be applied, the reflection of theories in business situation are analyzed through interviews with real IPOs and factories which are using IPO in Vietnam market. The paper will try to explain the IPO decision from manager’s views, include what activities can be done by IPOs, possible advantages and disadvantages of IPO strategy on company’s activities and performance. From that, a common view about IPO strategy can be completed, including what activities can be assigned to IPOs, advantage, disadvantages of the offices and notices during establishment.
13 Figure 1: Theoretical framework
1.4.1. Supply chain management
Companies use the concept of SCM for years to overcome challenge in minimizing costs and meeting customer’s expectations (Muysinaliyev & Aktamov, 2014). The concept can cover various aspects of company’s activities, including purchasing, planning, logistics, etc.
Therefore, SCM was researched in many ways. Firstly, SCM is an integrated process to create sustainable value and competitive advantages via delivering customer products and services (Ibrahim et al., 2015). According to Ganeshan & Terry (1995), SCM can be a network of facilities and logistics options to transform raw materials to finished goods and distribute to end customer. In a way, SCM is considered as a group of organizations, with upstream and downstream linkages, working together to produce value of products and services in the hand of end customers (Christopher, 1998). To summarize, SCM is a strategic and systematic coordination of the business functions and tactics across them for the purposes of improving long-term performance of not only any individual company but also whole supply chain (Ibrahim et al., 2015).
Global sourcing
Offshoring
IPO strategy
• IPO's Activities
• Advantages
• Disadvantages
14 1.4.2. Global supply chain
Globalization brings new operation trends and demands. Participation in global market gives opportunities to approach new low-cost options, diversity sources, new technologies and expanding capacity. However, it raises competition pressures on both buyers and suppliers in many aspects (Ibrahim et al., 2015). Globalization process is considered as the main source to lead company and manager’s thinking and strategies from local to global perspectives, and the concept of supply chain management has been broadened to global supply chain management.
(Wang & Song, 2017). Global supply chain can be defined as an active global supply network, which is managed by buyers (Wang & Song, 2017). According to Klassen & Whybark (1994), global supply chain can also be a network of factories and sources on a worldwide basis.
1.4.3. Strategic sourcing
Strategic sourcing is a key component of supply chain strategy (Su & Gargeya, 2012).
According to Kim & Chai (2017), strategic sourcing is a process of supply network design and management to achieve chain’s objectives. From the company’s view, strategic sourcing is defined as the process of sourcing decision making, includes planning, implementing, managing and evaluating to meet the firm’s goals and objectives (Su & Gargeya, 2012). In the objective view, the concept is processing to reduce risks and increase company’s flexibilities to improve company’s performance (Su & Gargeya, 2012). It can also be viewed as critical source to develop company’s competitive advantages and capabilities.
1.4.4. Offshoring
The main idea of offshoring is to transfer some of company’s activities to low-cost countries, mainly for economic purposes (Felice et al., 2015). It can be the relocation of production or intermediate inputs from local to a foreign country (Brandle, 2015). Or it can be defined as a process of coordinating and sourcing business tasks and functions across national borders (Musteen, 2016). Although the initial purpose is cost saving, the scope of offshoring was broadened to other aspects, such as company’s benefits and product quality. As a result, companies look for benefits rather than costs while do offshoring decisions (Brandle, 2015).
15 1.5. Thesis structure
This thesis is organized into five main parts: introduction, theories, research methodology, empirical research and conclusion. Figure 3 presents how the paper is structured and how parts are connected to each other.
The introduction part discusses how current business situations affect company’s strategies and lead firms to use IPO strategy as a choice for sustainable success. The first part also provides the basic information about the concepts and how it would be researched through the background, research questions, theory framework and related key concepts. Chapter 2 introduces the IPO strategy and its related theories and concepts: business process re- engineering and global sourcing. This chapter is based on literature review and previous theories.
Chapters 3 and 4 present how the paper is processed. Chapter 3 includes research methodology, research design, data collection plan and how data would be analyzed. The next chapter describes how the plan applied. Chapter 4 also includes summary of research findings, results of stages and implications.
Chapter 5: conclusion summarizes the theoretical parts with the answers for research questions from results. It also makes suggestions for companies and future possible topics for other researchers.
16 Figure 2: Thesis structure
2.2 Offshoring
17 2. IPO THEORY
2.1. Global sourcing
2.1.1. Global sourcing becomes survival strategy in globalization age
From the beginning, globalization is considered as one-way process, in which no company can avoid or choose to ignore its impacts (Senft, 2014). The process lowers both visible and invisible barriers among countries, global flows are increased, previously secured domestic markets face the risks of joining of oversea competitors and local competitors also look increase their competitive advantages via new sources (Rajagopal & Bernard, 1994). The strongest phenomenon of globalization, the establishment of trade blocs, like GATT, WTO, ASEAN and EU create free freedoms of goods, capital, people and services. Moreover, technology innovations allow the spread and accessibility of information, standardization and scaling. The internet helps global business relationship establishment and management work with low cost and time requirement (Senft, 2014).
However, globalization makes everything faster. It increases individualization and changing of customer requirements (Senft, 2014). The spread of technology allows companies to access new technology quicker, but it creates pressure of shortening technical processes and product life cycle (Senft, 2014). Therefore, companies always operate under the pressure of new coming products, new competitors or customer demand of better products. The new competition pressure forces company out of their comfort zone, where loyalty with existing businesses and other traditional domestic market elements cannot guarantee the growth and desired profitability (Rajagopal & Bernard, 1994).
Traditionally, cost advantages are recognized as the primary reason to go global (Rajagopal &
Bernard, 1993). Cheaper labor, lower, rent and facility cost or even less-restricted rules and taxes outright from host countries may reduce product cost from 30 to 50 percent comparing to local choices (Rajagopal & Bernard, 1993). Nevertheless, global sourcing benefits do not involve merely cost reductions, according to Senft (2014), they can be grouped into three key factors: are price, quality and time advantages.
18 There is one common problem many companies face when changing from local to overseas sources: because of the combination of high competition pressures and potentials, companies make decision too fast without enough preceding consideration. After one or two successful shipments, the companies are satisfied with partner’s performance and convinced that their supplier will keep their performance for years. However, problems may occur soon, like poor quality, wrong materials and capacity, wrong standards with samples. It is very hard to turn back since their production lines or other abilities are removed or using for another task after companies transfer from internal to external sources, and global sourcing can be the decision which damages or even leads to insolvency of the company. (Senft, 2014)
2.1.2. Global sourcing concept
Globalization of sourcing, or sourcing goods globally is not a new phenomenon. Many companies, especially from developed countries have been used for foreign lower-cost sources for years. However, there is one noticeable trend, in which companies increase their variation of sources in product destinations, types of items and sourcing quantity (Byrne, 2004). In this situation, these business terms “globalization”, “global marketing”, “global products” and other related terms have become buzzwords in economics fields and received growing interests from researchers (Holweg et al., 2011).
However, at the beginning, the term “global sourcing” was mixed in group with “global procurement” and “international sourcing”. They are used synonymously in research papers until getting a consensus which provided the first concept of global sourcing. According to Monczka & Trent (1991), global sourcing is considered as the final stage of purchasing strategy evolution, when companies seek for foreign sources in their supply network. More recently, global sourcing can be seen as the sourcing agreements outside of the domestic market, no matter where products are assembled or being sold (Holweg et al., 2011).
In this thesis, the most common definition of global sourcing is used, following works of Trent
& Monczka (2003) and supported by Hultman et al., (2012); Schneider et al., (2013):
“integration and coordination of items and materials, designs, processes, and technologies across worldwide locations of firms and their networks”. According to Trent & Monczka (2003), the concept distinguished global sourcing from international sourcing for these reasons:
19 differences in firm size and competitors, perspectives in strategy implementation, opportunities and threats as well as how they face and solve international problems. This concept focuses more on phases and transactions of commercial purchasing between the firm and external supplier from another country.
2.1.3. Global sourcing: Benefits and challenges Rationale of global sourcing
There are various factors that lead to global sourcing decision, with cost reduction as the primary reason. However, companies also search for other benefits via new business relationships (Holweg et al., 2011). There are many ways to classify these reasons. In this literature, benefits of global sourcing are introduced following two grouping methods supported by Cho & Kang (2000), Trautmann, et al., (2009). According to Monczka & Trent (1991), Cho & Kang (2000), major benefits which companies look for when they use global sourcing are cost reduction, quality and availability.
Cost reduction. Firms always want to purchase quality products at a low cost, so searching for the cheapest possible sources is the primary outcome managers expect when changing from local to global sourcing (Trent & Monczka, 2003b). However, researchers also conclude that managers focus more on unit price than total cost or ownership, so managers may decide to go to global with only lower purchasing price motives (Trent & Monczka, 2003b). For mass production, providing the same materials or same quality products at lower prices is critical. It becomes more important in mature markets where differences of available products are little, a big competitive advantage can be created by cost reduction (Cho & Kang, 2000).
There is also a consensus of researchers in global sourcing phenomenon that companies try to achieve cost advantages by using low-wage sources (Trent & Monczka, 2003b). Global sourcing is encouraged by exploitation of phenomenon that reallocating activities in supply chain to lower price destinations (Vos et al., 2016). However, according to Trent & Monczka (2003b), choosing sources by finding lowest price is more likely to aim at short-term benefits than long term strategy. In other words, this is rather tactical than coordinated decisions.
20 Quality. In the global business today, where everything changes so quickly product quality becomes very important for company’s survival. More and more customers are willing to get good quality products even with higher prices. Reaching higher quality level via global sourcing could be a competitive strategy, allowing company to build a leading brand and increase customer loyalty. When setting priority for quality improvement, normally low-cost countries do not have advantages, companies always choose other options, such as Germany, Italy or England. (Cho & Kang, 2000). Quality advantage achievements is not only quality improvement. For some products, high quality is compulsory, for others, quality can be just
“enough” (Gail, 2008). The term “quality” can be varied by type of products, region and country (Gail, 2008). So, it is important to define strategies to follow, target customers and others environment elements (Gail, 2008). In addition, cost and quality objectives can be attained by improving efficient and effective of technology (Cho & Kang, 2000).
Availability. According to Cho & Kang (2000), the biggest reason to change from local to global sourcing in many industries is unavailability of needed materials and products in domestic market. Sometimes, the need is not only about products but also includes other resources, like expertise and technology (Gail, 2008). Global sourcing can be the solution for material shortage problems, all caused by natural crisis or politics and technological elements (Gail, 2008). In fact, lack of local sources can be caused by global sourcing. Since orders move to foreign organizations, existing local sources must look for new customers to fulfill current production demand (Cho & Kang, 2000). Some companies succeed, others disappear. In addition, globalization offer opportunities for overseas suppliers to join domestic market, it creates competition pressures and, in some cases, destroy local suppliers (Cho & Kang, 2000). When companies want to back sourcing, they may not use the strategy because their previous suppliers might disappear, or these suppliers do not want to work with them anymore. In other words, this phenomenon reduces availability of local sources (Cho & Kang, 2000).
Beside cost reduction, quality and availability, there are many benefits that lead to global sourcing decision including improvement of company image and achievement of better delivery terms, lead-time, international competitiveness, etc. (Cho & Kang, 2000). These benefits can be grouped to motivations to achieve economies of scale, process and information and learning.
21 Economies of scale: advantage of getting lower cost by spreading the fixed cost over big quantity of products (Hollensen, 2010). In global sourcing context, economies of scale potentials come from increasing degree of volume aggregation and geographic scope. To commence with, economies of scope can be gained through adding common requirements of products and reducing number of suppliers. These requirements can be used to not only improve negotiating position of the company but also reduce risks in production and design, reduce fixed cost per product to achieve efficiency. Moreover, by combining deliveries from “relevant supply markets”, global suppliers can reduce delivery cost and increase capacity to trigger the exploitation of economies of scale. (Trautmann et al., 2009)
Economies of process: in global environment, economies of process can be understood as global standardization of work processes based on best practices (Faes et al., 2000). Benefits come from reduction of transaction volume and process complexity. The indicators reflect number of transactions and steps in global purchasing processes. In global sourcing, when numbers of supplier are reduced, companies have tendency to build strategic relationship with smaller number of suppliers. In this procedure, steps in procurement process, including special investigation and addition testing are reduced; common work processes can be created across suppliers in different areas. In other words, global procurement processes are simplified and optimized. (Trautmann et al., 2009)
Economies of information and learning: this synergy comes from the subject to leverage knowledge and information in supply chain system (Trautmann et al., 2009). Information includes purchasing knowledge, market intelligent, new technology, applications, and prevention of leaking of information regarding users, strategies and affiliates (Faes et al., 2000).
The advantage of global corporation in this situation is sharing information between headquarter and sites about risks, uncertainty and other information which used in decision making process, especially when purchasing complexity is high (Trautmann et al., 2009). Thus, global sourcing gives firms more options, they can decide by themselves when purchasing complexity is low or collect information from other sites before making decision when they have too much information and knowledge to process (Trautmann et al., 2009).
22 Environmental and Sustainability Risk
Global sourcing risks
Although global sourcing becomes popular and has been receiving increasing interest from scientists, a lot of its risks still need to be solved (Handfield, 1994). These problems include logistics delays, trade regulations, quality insurances, etc. (Handfield, 1994). Christopher et al., (2011) argue that global sourcing risks could be classified into four main groups following supply chain risk: supply risks, environmental and sustainability risks, demand risks, process and control risks:
Figure 3: Sources of Risks in Supply chain (Christopher and Peck (2004))
Supply risk means disturbances of material or information flow within supply network on upstream of the firm (Christopher & Peck, 2004). Local procurement is not a simple matter, but global sourcing is more complicated and difficult (Cho & Kang, 2001). Global logistics covers larger scope with higher requirements of lead time, safety stock and management of longer distant (Cho & Kang, 2000). Global transportation can be different from the local system and network. Thus, delays can occur, supply efficiency is reduced. According to Cho & Kang (2000), managing international supply network is considered the biggest challenge of global sourcing process.
Process and control are business terms of activities, rules and assumptions to manage assets and create value through supply chain. Process and control risks describe disruptions or misapplications of rules in working procedures (Christopher & Peck, 2004). Using global
Supply Risk Process Risk Demand Risk
Control Risk
23 sourcing lengthens required time for working steps, including ordering, co-designing, manufacturing, quality controlling and shipping. Thus, global souring weakens adjacency in supply chain since not value-adding time occurs (Wilding & Braithwaite, 2007). Although these problems first affect the company, their consequences also have impact on other elements of upstream and downstream supply chain, or in other words, the “bullwhip effect” is triggered (Christopher et al., 2011). Also, due to moving of productions to new destination and execution of long distance relationships, responsiveness of parties can be reduced (Wilding & Braithwaite, 2007).
Demand risk is not only uncertainty in purchase quantities of end users but also disturbances to information and product flow in downstream part of supply chain, between the firm and their market (Christopher & Peck, 2004). These risks can be disruptions from new coming products, demand variations of seasonality and other factors. Demand risk can also come from consumer market and draw visible effects to global sourcing activities (Christopher et al., 2011).
Environmental and sustainability risk: Christopher & Peck (2004) provides concept of environmental risk as uncertainties having impact on all elements in global supply chain, all the focal firms, suppliers and customers in value network. These events can come from socio- political, technological or economic events (Christopher & Peck, 2004). They are sometimes predictable, however, some of them are not, so their impacts are still assessed (Christopher &
Peck, 2004). To adapt company’s strategy following sustainable perspective, Christopher et al., (2011) developed the concept “environmental and sustainability risk”, in which risks may impact on the sustainable procurement of the company. These risks can be production and delivery under non-optimized situations, waste generation and other environment issues, such as greenhouse gases and CO2 (Christopher et al., 2011).
2.1.4. Global sourcing choices: The dynamics of Offshoring and Outsourcing
In the previous part of this chapter, it is showed that every company must face a critical question in modern global economy: “What is the optimal organization and configuration for company in globalization situation?” Many of them choose global sourcing as their core activities.
Sourcing strategy involves company decisions on the use of suppliers and their products and services to serve a market (Kotabe & Murray, 2004). In other words, the strategy concerns the
24 scenario in which business activities are operated in the local areas (onshore) or oversea (offshore) and by the company (in-house) or their parties (outsource) (Dedrick et al., 2011).
Outsourcing and offshoring have close connection to answer a mutual question, what is optimal level of control and management on firm’s business activities (Mudambi & Venzin, 2010).
Contractor et al., (2011), Metters (2008), Dedrick et al., (2011) provided a common perspective on sourcing strategy: outsourcing, and offshoring are better viewed in a spectrum than category.
The spectrum of sourcing decision could be studied from contractual and location point of view.
From contractual aspect, sourcing activities of components and products are operated via relationships with (1) headquarter or their subsidiaries “intrafirm sourcing” (2) independent suppliers “outsource sourcing”. On location aspect, multinational firms can collect necessary resources and service domestically or from abroad “offshore sourcing” (Kotabe & Murray, 2004). The links among sourcing types are described in the paragraph below, in which the term
“offshoring” refers to combination of cells (C), (D1), (D2) and “outsourcing” is value added by contractual relationships in (B2) and (D2) (Contractor et al., 2011)
Figure 4: Global sourcing choices (Contractor et al., (2011))
25 The most simple and traditional way is companies add value “in-house” and in “home nation”.
After that, the firm choose to move their business activities internally, both home land and subsidiaries in other countries where company can have “core competence”, usually from cost reduction (Contractor et al., 2011). In other way, companies expand their business arm-length from inhouse to outsourcing, in which they give non-core competence activities to external providers. The cooperative relationship is “half-way strategy”, between using completely in- house and contract-based suppliers. These methods have the same objective with to transfer functions which cannot achieve best performance in-house or at home to their subsidiaries and external vendors globally. (Contractor et al., 2011)
When using the strategy, companies have to not only evaluate results from analyzing complex data of business intelligence, includes costs, available infrastructure, support industrials, culture but also consider their objectives of efficiency, flexibility, performance and risks. According to Metters (2008), level of company’s outsourcing and offshoring decision corresponds to their assumed risks levels. Moreover, for major components, location decisions have less impact on company performance than how to operate global sourcing strategy. So, when examining choices, it is necessary to define clearly sourcing on “intrafirm” or “outsourcing” because it will have long term impact on sustainable success (Kotabe & Murray, 2004).
2.2. Offshoring
2.2.1. On the concepts of offshoring
In the previous part, offshoring is showed as the consequence of globalization, in which companies consider relocation of business activities to regions where their investments can get higher return (Jahns et al., 2006). Thus, it received more and more interests in the field of global supply chain strategy. However, the first concept of offshoring was first introduced in 1990 and is still being debated (Radlo, 2016). So, it is necessary to discuss about different perspectives before going to a definition of “offshoring”.
The first inaccurate understanding is that in global purchasing areas, “offshoring” and “offshore outsourcing” concepts are using interchangeably (Jahns et al., 2006). Offshoring can be understood as the relocation of business activities from home to foreign country (Pedersen et al., 2013). Outsourcing is combination of “outside”, “using” “resource”, a make-buy decision
26 in which managers decide to change sources of item from internal to external (from making to buying materials and products) (Jahns et al., 2006). These sources can be affiliated firms or external organizations. However, the concept of offshoring should not be limited to use external sources (Jahns et al., 2006).
Secondly, regarding scope and details of offshoring, some scientists still illustrate the concept as a phenomenon of outsourcing, reflect on geography scope. Bruce & Martz (2007) describe offshoring as a special version of outsourcing, when firms use this strategy in foreign countries or areas. It is also viewed as outsourcing activities with an oversea partner (Tadelis, 2007).
However, the offshore agreement can be with both firm’s unaffiliated and affiliated organization as well as be external and captive (Plankenhorn, 2008). So, the concept of offshoring need to recapture to cover all its phenomenon.
Thirdly, it is necessary to differentiate the geographic dimension of offshoring. Offshoring is transferring activities to lower-cost location (Pfannenstein, 2004) is one of inaccurate understanding. In fact, offshoring occurs also among developing countries (Helpman, 2011).
Sometimes, using offshoring strategy for high-skill-intensive tasks does not raise cost effectiveness (Helpman, 2011). Also, researchers provide many definitions of geographic dimensions of offshoring: outside of “country’s boundaries”, “first world”, “continent”, etc.
(Jahns et al., 2006). These definitions lead to heterogeneity in understanding and unpredicted issues when firms apply this sourcing strategy.
The concept of offshoring comes from the meaning of the adverb “offshore” (outside, far from the country) created by combination of “off” (far from the side) and shore (the coast) (Helpman, 2011). This concept was first described as the oversea relocation of production (Helpman, 2011). Offshoring can be defined as shifting business activities that were operated within national borders to affiliated or unaffiliated firms (Plankenhorn, 2008). It covers these situations:
- Transfer abroad a part of production and service within an international corporation (offshore inhouse sourcing. The company will transfer activities to their foreign affiliates. These subsidiaries can be existing or created when the firm make offshoring decisions. (OECD, 2007)
27 - Activities transferred abroad between company and a non-affiliated organization (offshore outsourcing) under subcontracting phenomenon. These non-affiliates can be controlled by residents of host country, by a third party or by outsourcing subsidiary of another group. (OECD, 2007)
2.2.2. Theoretical aspects of offshoring decision:
Offshoring offers new opportunities for companies in globalization environment (Roza et al., 2011). It has a strong link to “make-or-buy” decision, in which companies decide which activities they perform inhouse or use external sources (Roza et al., 2011). In this part of thesis, offshoring decision will be explained via efficiency and capability views. On efficiency cluster, offshoring strategy is leaded by efficiency and transaction cost economics theory (TCE). On the other aspect, resource-based view is used to analysis the decision.
Efficiency perspectives:
Companies can improve efficiency on operational, managerial and financial synergy classes via offshoring (Roza et al., 2011). At the beginning of offshoring relationship, if the firm uses existing infrastructure, both firm and their suppliers can optimize their own capacity, which leads to operational efficiency (Achleitner, 2001). On managerial aspect, by establishing partnership in offshoring, capital and other resources can be avoided from privileged scarcity appreciation in the market, which cannot be accessed with a single operation (Achleitner, 2001).
The expansion of collaboration and partnership via offshoring also have measurable value of a certain project. (Achleitner, 2001).
Also, advantages of offshoring can be analyzed on faster and more efficiency firm’s cash flow, including risk, cost, capital and capacity issues. The most noticeable benefit of offshoring which companies always look for is cost reduction. On financial aspect, moving out business activities helps company access opportunity for lower cost of capital, factor and labor. In addition, transferring assets to partners or selling unnecessary infrastructure, tools, machine or other equipment via offshoring creates more available capital as well as reduces fixed cost and risk.
Moreover, economies of scale and scope can be reached via using available resources of parties in offshoring contract, which is rarely achieved by any single firm. (Plankenhorn, 2008)
28 In transaction cost economics (TCE) theory, transaction cost includes cost related to search, negotiating, planning, monitoring and enforcement (Blomqvist et al., 2002). Thanks to offshoring, foreign suppliers can be managed in an intermediate market, thus reducing transaction cost (Roza et al., 2011). Firm can move business function to areas where operation cost is lower. In addition, offshore locations may offer a lager choice of vendors, which will lessen searching and negotiation cost (Mykhaylenko et al., 2015). Also, creating offshoring relationship reduces management and enforcement cost. Having a partner with mutual trust and objectives allows firms to reduce efforts in searching, approaching and negotiating new contracts. Also, parties may skip irrelevant activities, conflicting opportunities and strategies to support offshoring agreement for a long-term relationship (Plankenhorn, 2008).
Resources and capacity views
Resource-based view (RBV) theory studies the internal resources which form company’s core activities and competitive advantages (Plankenhorn, 2008). These resources are considered important when they are rare, valuable, non-substitutable and imperfectly imitable, for example skilled labor, talents, capabilities or innovation in offshored location (Mykhaylenko et al., 2015). RBV theory explains motives of offshoring based on firm’s willingness to have inter- organizational agreements. If company cannot prepare enough necessary resources internally or from easily-obtained way in the market, they will look for collaboration relationship. Unlike merger or acquisition, offshore offers more affordable opportunities to access availability of resources and incur more strategic options in the future (Plankenhorn, 2008). This solution offers higher advantages when targeted resources are unique and cannot be substituted when traded out (Plankenhorn, 2008). Also, offshoring is an effective strategy to optimize firm’s performance from internal capabilities and resources (Roza et al., 2011).
Organizational learning theory suggests that firms gain competitive advantages by using internal knowledge. The theory changes firm’s focus from transactions to the requirement of learning, innovation and optimization of capability utilization (Vivek et al., 2009). Therefore, each company has three options to success: develop knowledge internally, buy them or engage in strategic partnerships with other organizations (Plankenhorn, 2008). Like the implications from RBV view, firms choose to fill the gaps and inabilities by using offshoring relationship through
29 knowledge potential. The networking among companies has high effectiveness in passing information on processing complexity, market intelligence, product developments and other economic factors (Mohiuddin, 2011) Offshoring strategy plays a role in allowing access relevant information and create exchange knowledge environment among parties (Plankenhorn, 2008).
In other perspective, some researchers argue that firms can develop competitive advantages via their own supply chain network, in which members work together to achieve the best performance, thus each of them can maximize their own value added (Mohiuddin, 2011). This approach can be considered as relationship-based view, including relationships, network and interactions between two or more parties (Vivek et al., 2009). This theoretical evolution supports the trend that firms are changing offshoring priority objective from cost saving to value creation to get into a long term strategic relationship (Mohiuddin, 2011). These relationships are built from trust and commitment on the mutual view on costs, benefits, communication, shared values and opportunistic behaviors (Vivek et al., 2009).
It is clearly seen that there are connections among these theories regarding reasons for companies to choose offshoring strategy. The dynamics of these theories create broadened view on how to develop competitive advantages through internal and external resources. In addition, learning, innovation, efficiency, flexibility and collaboration are important goals leading to this decision. Also, firm’s motivation can move from cost saving to value adding and opportunism hedging to integrated efficiency by trust and commitments. However, these views just describe implicit motives of offshoring, and these motives still need to be transferred to specific target to be easily measured and monitored. On the next part, specific objectives will be discussed.
2.2.3. Offshoring motives
On the previous part, some theories were illustrated to explain implicit motives, or in other words, theoretical foundations which companies can look for to build their own objectives and goals as well as consider offshoring decision. Also, some scientists did empirical researches about common company’s objectives. Some objective clusters, include reducing costs are mentioned. Firms can develop their strategy based on both implicit and explicit motives.
Cost saving: in the perspective of transaction cost economics theory (TCE), cost saving is most frequently the objective firms want to achieve by offshoring. In case of USA and German
30 companies, more than a half of labor cost can be saved via the strategy (Farrell, 2005). More than 70 percentage of companies consider offshoring as their prime objective (Plankenhorn, 2008). Articles supported by Plankenhorn (2008), Roza et al., (2011) also show that economic advantage is not achieved only by using cheaper labor force, it can be reached from reducing in communication related costs, setup costs, or from differences in tax, supplier’s potential margin and economies of scope.
However, in terms of cost advantages, there are two questions should be raised which activities should be sent to offshore location and how to balance cost saving and benefits from offshoring decision. According to Plankenhorn (2008), one possible example could be the education gap:
the differences between “university-educated, young, skilled” employees, when firms cannot offshore because their target location can provide cheap but low quality of employees.
Moreover, using offshoring strategy requires extra business steps/activities, so it can increase transaction costs, which will offset the saving (Roza et al., 2011).
Advantages on focus on core: this objective comes from the idea that some firm’s activities, including customer services, data handing, information management, etc. can be operated in the same processes. In other words, they are general activities, which can be decoupled and processed outside by professional agents (Kedia & Mukherjee, 2009). Company’s vertical integration is reduced, the organization has more space and resources to focus on small set of core activities (Plankenhorn, 2008). Well-developed core activities can lead to core competencies and competitive advantages and help companies keep and increase their market share (Kedia & Mukherjee, 2009). As a result, companies have right to optimize their efficiency by focusing on small group of activities and letting other firms do the rest (Plankenhorn, 2008).
Flexibility is also one of the common benefits from offshoring. Flexibility is the ability to transform company’s activities and perform new things (Kedia & Mukherjee, 2009). Benefits from reducing assets, threats of demand fluctuations, skill requirements are the main factors encouraging company’s offshoring strategy (Plankenhorn, 2008). From financial view, offshoring allows company to remove non-core activities and fixed assets. The more specific assets a company has, the more difficult it is to make a new investment or to face a peak demand.
Skill requirement are also an element of offshoring motives. To approach the needed skills to
31 make companies’ processes more flexible, a company can choose offshoring as a solution.
However, offshoring has negative attractiveness when the firm sets priority on keeping the company’s dependency and core competencies. Also, offshoring brings advantage when company can move their activities out of strictly regulated countries and static labor market, where they cannot adjust their employees easily (Plankenhorn, 2008).
Location-related advantages: country-specific attractiveness is one of the most highlighted motives of offshoring. These advantages can come from country’s environment elements, such as policies, infrastructures, etc. India, Malaysia and the Philippines can offer university graduated employees to work in call centers at a low salary, this would not be possible in developed countries. Thanks to difference in time zones, works can be processed continuously at night. For example, a doctor can take X-ray plates, send them to other countries to analyze and when he goes to the office next morning, the results are ready. Most countries have their own trade and tariff barriers to protect their economy, and offshoring is an effective solution to break the wall. (Kedia & Mukherjee, 2009).
Besides these advantages, other literatures discuss other motives, like improved quality, service or knowledge learning. Motives and their relations are showed in the matrix below. It also so that some benefits and motives of offshoring can occur in home country location, which leads to the usage of local offshore strategy, when a company moves their activity out, but not out of country bounders.
32 Figure 5: Offshoring motives (Plankenhorn (2008))
2.2.4. Risks
Offshoring drives companies to a new complexity level of benefits and risk management due to transferring from local to global operations and moving business activities from internal to external. some articles presented that offshoring risks occur when companies use a third party to operate their business, which is close to standard outsourcing risks (FDIC, 2004). So, it is clearly seen that the dimensions of offshoring risks need to be improved following the expansion of offshoring concept. (Kumar et al., 2009). (FDIC, 2004) introduced an effective way to classify offshoring risks based on company’s critical areas of competency, including delivery performance and relationship field. In this method, delivery performance is separated to groups
33 of strategic, operational and credit risks. Factors influencing firm’s brand are grouped into country, compliance and reputation related causes.
Figure 6: Offshoring risks (Kumar, et al., (2009))
The first posed group is strategic risk, which is considered as the most significant threat, because it affects both short and long-term planning of the firm. Strategic risks are related to the leak of intellectual property (IP), trade secrets or special process techniques (Massini et al., 2010).
When a company offshores a business activity, sharing of business information is always a part of the agreement. Sometimes, it is necessary to share information on unique techniques, innovative processes or new product development plans (Kumar et al., 2009). Success offshore agreement includes the prevention of the risk that a party uses this information for their own products and sell to other customers, leaks the information or sells information to other competitors. Also, sharing and communicating to get mutual visions and long-term goals should be concentrated to reduce mismatch in working, misunderstanding, to improve trust and avoid unexpected activities from all parties (Ellram et al., 2008).
Operational risk has strong connection with uncertainties in quality service, production cost or process operations. Sources of this risk include people, technology and process problems (Kumar et al., 2009). People risk has a strong link with differences in cultures and education level between home country and host countries. Technology risk is connected with business relationships and the transfer of work processes between the company and its vendors (Kumar et al., 2009). Processes problems come from the ineffectiveness and inefficiency of business measurements (Kumar et al., 2009). In addition, operation risk can come from mismatch in firm
34 structure between parties in offshoring agreement, which lead to unexpected problems in network relationships and processes. The root causes of operational risk are mentioned as lack of planning, strategic preparation or incompleteness of contract specifications (FDIC, 2004).
Companies can reduce uncertainties and transaction costs from day-to-day monitoring by carefully preparing visions, strategies and negotiation process to get clear mutual views and requirements (Ellram et al., 2008).
Compliance risk relates to the uncertainties of company’s income due to regulations, nonconformance with standards and policies or violations of laws (FDIC, 2004). Various sets of laws are applied for working in different countries (Kumar et al., 2009). When joining an overseas market, conflicts between company’s activities and standards of ethics and laws in host areas can easily incur. If the company does not consider thoroughly enough, failures will lead to danger of breaking laws (FDIC, 2004). Studying market volatility risk, classifying and preparing solutions to reduce risk is necessary (Ellram et al., 2008).
Reputation risk effects on capital arises or earning on company’s markets (FDIC, 2004).
Normally, offshoring is viewed as a negative business phenomenon with home field, since it encourages the transfer of jobs, business activities and organizations from a country to others (Kumar et al., 2009). As a result, it causes loss of jobs and increasing unemployment rates, which might harm economy development and social welfare. company’s brand and sales may be hurt by offshoring decisions if customers put a pressure to keep production in the home country (Kumar et al., 2009). Moreover, reputation risk may come if a company’s vendor has a reputation problem. in 2010 Apple had to face a serious PR problem when their main offshore factory received complaints on overly-strenuous working conditions and employment of teenager workers (Bush, 2010).
In fact, when using offshoring activities, many companies underestimate credit risk (Kumar et al., 2009). The risk may occur when a party cannot meet their financial responsibility following offshore agreement (FDIC, 2004). Another problem may come from restricts in policies and laws. For example, the risk can come from restrict in recouping receivables. Some countries do not allow reclaiming money from a past-due account (Kumar et al., 2009). So, credit risk is different among countries and becoming more complex for global organizations (Kumar et al.,
35 2009). So, companies need a good preparation as well as an appropriate financial monitoring with their partners to avoid unexpected events (FDIC, 2004).
Country risk includes problems from socio-economic conditions, political elements and other issues related to a particular country (Kumar et al., 2009). The most mentioned risk is political uncertainty. Some countries cannot attract foreign investor because of civil unrest. In this situation, war is an element which reduces ability and productive environment in the area (Kumar et al., 2009). Moreover, imperfect relationship among countries can also have a negative impact. The conflict can be between home and host country (FDIC, 2004) or host country and their neighbors (Ellram et al., 2008). Firms need to take an eye on the political risk of interruptions of processes and services during operation business due to nation’s relationships (Ellram et al., 2008).
2.3. IPO
2.3.1. IPO as a part of global sourcing stages
Global sourcing brings company benefits and survival; however, it requires high integration and proactive coordination level of worldwide purchasing on common materials, designs, technologies, processes and supplier management (Trent & Monczka, 2003b). The IPO concept received many interests in explaining how company can gain advantages by analyzing their expanding business process, mostly by using two common dimensions: development from transactional to strategic sourcing and spreading their business activities to access global market (Jia et al., 2014b). In both views, establishment of IPOs is defined as a necessary step that companies need to consider from international to global (Jia et al., 2014).
The strategic view describes establishment of IPOs as an important requirement when purchasing activities become more complex (Giunipero & Monczka, 1997). When spending for purchasing increases, the company realizes the need to minimize transaction and production cost, or in other words, improve their activity efficiencies (Giunipero & Monczka, 1997).
Establishing an IPO is viewed as a commitment to global sourcing strategy, by playing the role of allocating buyers, managing or support purchasing activities (Trent & Monczka, 2003). Also, the office can take responsibility for deciding the type of business relationship among headquarter, subsidiaries and suppliers (Giunipero & Monczka, 1997).
36 On the second aspect, researchers take view on a firm’s expanding procurement horizons, with several levels of purchasing and global sourcing (Rajagopal & Bernard, 1993). This perspective comes with a view from “traditional” purchasing activities to a creative and proactive methods to operate global sourcing (Rajagopal & Bernard, 1994). These researchers also indicate that each steps or movement of company on global sourcing management is decided on a set of objectives, constraints and commitments with their vendors (Rajagopal & Bernard, 1993). The globalization of company may be considered as a process from when a firm only uses local market to has complex sourcing network from different countries. In this thesis, I would like to introduce a model supported by Rajagopal & Bernard (1993), Trent & Monczka (2003b), which studies globalization process of company from their activities and peaks because it is easier to help companies realize the level or their business activities and provide a basic view about effectiveness of their strategies and what happens next on their future development.
Level 1, domestic sourcing, is the stage when firms use only local sources, because they perceive global sources unnecessary, do not see priorities or do not have experience (Trent & Monczka, 2002). Domestic suppliers can fulfill all company’s requirements (Trent & Monczka, 2002). At this level, purchasing’s role in the company is still limited to price and delivery management, it is seen as a service function for the rest of the company (Rajagopal & Bernard, 1993).
In the next level, companies purchase from their suppliers or market’s available distributors, or in other name, indirect importing method (Trent & Monczka, 2002). suppliers are in charge of managing international transaction (Trent & Monczka, 2002) or the company can use simple offshore purchasing (Rajagopal & Bernard, 1993). Rajagopal & Bernard (1993) also notice another phenomenon at this level, when company use foreign agents or distributors to get materials and products, or direct importing. This method will increase the risk in quality and delivery of products. In addition, when company must depend on a small number of suppliers, the decision has limited flexibility and effectiveness on company’s performance, too (Rajagopal
& Bernard, 1993).
Third level of globalization participation is when companies realize benefits of global sourcing, mostly on potential performance improvement they can achieve (Trent & Monczka, 2002).
Company can purchase goods and products through their overseas subsidiaries or other
